May 21, 2024

How does a balanced advantage fund work? How is it taxed?

How does a balanced advantage fund work? How is it taxed?


Investors know that one of the best ways to generate long-term wealth is to invest in equities. However, equities as an asset class are prone to volatility, which not every investor is comfortable facing. In the face of this conundrum, investors can choose to invest in a balanced advantage mutual fund such as the HDFC Balanced Advantage Fund. Here is how balanced advantage mutual funds work and how they can be a tax advantage for investors.


What are balanced advantage funds?

Balanced advantage funds (BAFS), a type of mutual fund provided by fund houses like the HDFC Mutual Fund house. These funds offer investors a balance between risk and returns. At the same time, they also offer the advantage of enhanced timing of investments. These mutual funds are also acknowledged as dynamic asset allocation funds and fall under the category of hybrid funds. These funds provide a hybrid asset allocation consisting of equity and debt that is actively managed as per the prevailing market conditions.Β 


How do balanced advantage funds work?

Balanced advantage funds like the HDFC Balanced Advantage Fund have a rebalancing strategy in-built into the fund where asset allocation is changed or managed to minimise risk and losses. These funds have a unique advantage where there are no pre-set limits for asset allocation. Dynamic asset allocation ensures that the investment of the fund in debt or equity is based on market conditions and performance. So, when the market is doing well, the fund’s investment in equities goes up. The strategy is to buy equities either at comparatively cheaper rates or even high rates, so long as they can sell those at higher rates. When markets are underperforming, these funds invest heavily in debt.

With balanced advantage funds, s fund house like the HDFC mutual Fund house has dedicated fund managers who oversee the asset allocation. They do this by using an Asset Allocation Model which is an in-house mathematical model that helps fund managers determine the optimum mix of debt and equity allocation under on-going market conditions.Β 


What are the advantages of balanced advantage funds?

  1. Potential for steady returns: These funds have a debt cushion that buffers their investments during times of market downturns. The debt asset allocation, therefore, acts as a buffer for the volatility of the equity allocation. So, the returns generated by these funds tend to be steady and stable.
  2. Dynamic asset allocation: The fund managers use dynamic asset allocation to manage the fund investment to lessen the risk of loss and to improve the chances of better returns. This strategy helps the fund managers make the most of whatever the prevailing market conditions may be and still come out as winners.Β 
  3. Comparatively lower risk: As the fund invests a portion of its corpus in debt instruments, it does not have complete exposure to equities. Therefore, the risk of capital erosion is reduced. Equities have a tendency to be volatile, putting off investors who have lower risk tolerance.Β 
  4. One-stop solution: These funds can act as a one-stop solution for investors looking to diversify their investment portfolio. The fund itself dynamically invests in both equities and debt asset classes, providing vital diversification for any investment portfolio.Β 


How are balanced advantage funds taxed?

Investors have a clear tax advantage when they invested in a balanced advantage fund. The way taxation on mutual funds works is that when investors manually transfer their investment between debt and equity and vice versa, they are subject to capital gains tax.Β Β 

However, with balanced advantage funds, the fund strategy is to routinely rebalance the fund portfolio between equity and debt. Since this transfer is a part of the fund strategy, investors are not taxed for it. Only when the investor opts to redeem their mutual fund units will they be taxed.


Balanced advantage funds are taxed as equity-oriented funds if they invest 65% or more of their corpus in equities, such as the HDFC Balanced Advantage Fund. Conversely, a balanced advantage fund that invests the bulk of its corpus in debt is taxed as a debt-oriented mutual fund. Most balanced advantage funds try to maintain a 65% investment in equity. One of the reasons is that equity-oriented funds have lower tax rates compared to debt-oriented funds.

So, with this, investors are taxed at 15% of short-term capital gains for fund units held for less than a year. Long-term capital gains exceeding Rs 1 lakh for units held for over a year are taxed at 10% without indexation.Β 


Summing up

Investors with moderate risk appetites, looking to generate a wealth corpus, with investment horizons of about 5 years should invest in balanced advantage funds. They should choose a reputed fund house like the HDFC mutual Fund house and consider the fund house expense ratio and past performance of the fund when choosing a suitable fund.


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